Network Vendors Gobble Each Other Up

FRAMINGHAM (02/11/2000) - More than $12 billion worth of acquisitions were announced last week by a slew of network companies, continuing a trend that shows no sign of stopping soon.

Interestingly, the companies doing the buying were a mix of large and small firms. These included Lucent and Nortel, as well as Akamai and Kana Communications, which have huge market capitalizations thanks to Wall Street's current infatuation with Internet stocks.

In fact, the biggest dollar deal was made by Kana Communications, which sells software that helps companies better manage e-mail. Kana set down $4.2 billion in stock to buy Silknet Software, which writes applications that let e-business customers check on orders.

That's a big bite for Kana, a company that ended 1999 with a net loss of about $119 million, but boasts a market capitalization of about $6.5 billion. It also seems a pretty penny to pay for a company that pulled in just under $8 million in revenue and lost nearly $4 million in the last quarter.

Financial experts, many of whom benefit from such transactions, claim that deals like the ones made last week can benefit customers. "It should translate into newer capabilities and more capabilities faster, and these capabilities should be better-integrated," says George VonGehr, managing partner of Alliant Partners, a Palo Alto firm that specializes in mergers and acquisitions.

For example, when a major vendor like Cisco buys two VPN vendors, customers should expect the acquired devices to be well-integrated with Cisco's management platform. They can also expect them to work with Cisco gear, VonGehr says.

The acquisition trend will continue as long as large vendors need to fill gaps in their product lines and as long as it is faster to buy than to build the missing gear, says Christopher Nicoll, an analyst with Current Analysis in Sterling, Va.

In addition, start-ups with enormous market capitalizations will continue to buy to justify the value Wall Street places on them, says Anthony Abate, a principal with Battery Ventures in Boston. These newcomers have easy access to funds that they use to buy other companies.

Those purchases should be designed to broaden the buyer's product line and bring in a new stream of revenue, Abate says. As long as they show the potential to do these two things, deals can be justified, he says. "It's a land grab. You grab first and worry about profitability later," Abate says.

Snapping up other companies also keeps them away from the competition, Von-Gehr says. "If you buy it, that means somebody else didn't," he says.

Larger companies, such as Cisco, Nortel and Lucent, buy for other reasons, such as filling specific gaps in their product lines, Nicoll says. As the vendors grow, some customers expect them to meet all their network needs, VonGehr says.

Sometimes the best way to do that is buying another company, he adds.

Large companies also buy smaller ones that have new technology. Nortel plunked down $3.25 billion last year for Qtera to get its hands on the start-up's patented long-haul optical technology. "Sometimes bigger companies need the innovation of smaller companies," VonGehr says.

The merger-acquisition trend is becoming a cycle that feeds itself, Nicoll says. As start-ups get absorbed, their top executives get restless and move on to form more start-ups, which also get bought.

For example, former Cascade executives are responsible for at least four start-ups, including the highly valued Sycamore Networks.